Stephen Long reported this story on Thursday, September 24, 2009 12:18:00

ASHLEY HALL: The latest Financial Stability Review by the Reserve Bank shows a huge increase in bad loans in the global banking system.

But the report concludes that the world's financial system is improving markedly. Our economics correspondent Stephen Long has been analysing the Financial Stability Review in a lock-up at Reserve Bank headquarters and he joins me now.

Stephen, what do you make of this document?

STEPHEN LONG: Well Ashley I guess the issue is whether you choose to focus on the reassuring conclusions or look at some of the worrying data within the report itself.

So the conclusion is that the global financial system has significantly improved and really that's just a statement of fact when you consider that we were a near systemic meltdown after the collapse of Lehman Brothers and credit markets were completely frozen and dysfunctional.

Now clearly things have improved significantly since then but you look at these bad loans and the Reserve Bank report notes that a selection of large global banks for which data is available have set aside provisions of $US142 billion in the first half of 2009 for bad loans and that is an increase of 70 per cent on the same period in 2008.

And that's just a selection of large banks. Beyond that there is myriad numbers of smaller and medium sized banks who are also declaring bad loans.

You look at the US housing market where now a third, a third of houses are in negative equity - that is the loan is worth more than the house, the cost of the loan is more than the worth of the house itself - and you have one in 11 home mortgages in arrears. People aren't keeping up with the payments as well as a 30 per cent fall in house prices and massive foreclosures. And you look at all of that and the US is 25 per cent of the world economy.

Things are a little bit better in Europe in those markets but not, and it notes also that commercial property is worse and you would have to come to the conclusion that there are still some worrying developments.

STEPHEN LONG: Well I think we have to understand the politics of the Financial Stability Review in the current context. It is in a sense, an unmitigated sales effort. The Reserve Bank wants us to be confident. It wants to install confidence and so it reaches positive conclusions and that colours the way it interprets some of the indicators.

For example it notes with apparent approval that global equity markets, stock markets have risen by 50 per cent on the key indicators around the world, key indexes around the world.

Now you could take that as a sign that things are good again or you could take it as a sign that we have got a new bubble.

And it notes that money market interest rates have fallen to levels not seen since 2007, very low levels, which we had before the crisis.

Now that clearly frees up borrowing and lending somewhat but it could also suggest that we have insufficient pricing for risk depending on whether you take a glass half full or a glass half empty approach to the data.

And the Reserve Bank clearly wants to take a glass half full view which it has done historically in the Financial Stability Reviews. Looking at these reports in the lead up to the crisis, you wouldn't have got a sense that it was coming.

ASHLEY HALL: But Australia is in a much better position?

STEPHEN LONG: Undoubtedly, and that is clear from the data. Although there has been a big increase in bad loan provisioning by banks here and I believe a tripling in bad loans for business, it comes from a very low base and it is clear that our financial system and our general economy is in better shape than the rest of the world.